The shareholders of Core Education & Technologies will not forget 25 February 2013, the Black Monday that brought to life their worst nightmare on the stock market. The rumours that lending institutions had sold the shares pledged to them by the promoters spread like wildfire and the stock tanked 62%, falling precipitously from Rs 295 to Rs 110.50. Two days later, it fell 45% to hit Rs 60. While Core Education & Technologies was, by far, the worst hit, the panic selling that has gripped the market in the past 2-3 weeks has seen several mid- and small-cap stocks drop by 30-50%.

In some cases, the decline was triggered by rumours of pledged shares being sold or corporate governance concerns spilling into the public domain. In other cases, bear cartels and wily operators manipulated the stock prices. This has prompted Sebi to launch a probe into the reasons that led to the mayhem.

The market watchdog suspects that a cabal of barred rogue traders operating through front entities was involved. However, the damage is done. Many investors have lost a huge chunk of their capital. Despite close monitoring by Sebi, the Indian stock market remains a fertile ground for price manipulation. The mid- and smallcap companies frequently witness wild swings in their stock prices. Small investors are usually the ones who suffer the most, even as unscrupulous operators laugh all the way to the exchange.

If price manipulation cannot be checked, should small investors stop buying shares altogether? That would be an extreme solution, but this is precisely what is keeping many potential investors away, believes Vijay Kedia, director of Kedia Securities. "Retail investors are not participating in the Indian capital market because most mid- and smallcap stocks are manipulated and operators are never caught," he says. Are your stocks also being manipulated? Read on to know the telltale signs of stock manipulation and how small investors can guard themselves against such dubious investments.

Problem of pledged shares

The mid-cap carnage in February was triggered by rumours of financial institutions selling the shares pledged by promoters. The latter often pledge a part of their holding as collateral for raising loans. This is a standard industry practice and, per se, not a reason to be alarmed. It's only when the promoter pledges a significantly large chunk of his holding and the overall floating stock of the company is very low that problems can crop up. Brokers often facilitate this funding route for smaller companies, which find it difficult to raise funds through the traditional routes. Even so, most lenders do not offer more than 60-70% of the value of the shares pledged.

This operator-driven, informal funding route exposes the stock to manipulation. Operators zero in on such stocks, hammering down the price to lower levels. The steep decline in the stock price makes the lender demand additional margin from the promoter. The borrower has to either cough up more shares or return some of the money to the lender, to ensure that the margin is maintained. Unfortunately, margin calls can sometimes have a domino effect on the share price. At the slightest hint that promoters are unable to arrange additional shares or funds, panic grips the market and the shares nosedive. This is what happened in the case of Core Education & Technologies.

How brokers are involved

Brokers also raise money for companies by putting up a basket of shares as collateral with financiers. This is safer than pledging shares of an individual company because the chances of the entire basket losing value are significantly lower. The financier agrees to lend the money to the broker (not the company), who, in turn, passes these funds to the promoters after taking his cut. This is what happened in February, when a number of companies borrowed money from brokers via this route. However, all hell broke loose when share prices fell and brokers were unable to stem the tide of margin calls from financiers. When they could not arrange the additional funds, the lenders dumped the pledged shares to recover the money.

This, in turn, led to a widespread slide in the share prices. Some market experts don't buy this logic. They doubt if margin calls can trigger such a huge crash. A Mumbai-based stock broker suggests, "It is a well-orchestrated game, wherein promoters and operators get together to jockey share prices." It is mostly the mid- and small-cap stocks that come on the radar of these operators. Experts agree that smaller stocks will always remain susceptible to manipulation. "The companies that have weak balance sheets and low volumes will remain vulnerable, more so till the economy recovers," says Saibal Ghosh, chief investment officer, Aegon Religare Life Insurance. The companies with high debt or those that have pledged a large portion of the promoters' shareholding are also at risk. If they spot a company with such credentials, bear cartels start hammering the prices in the derivative segment, which has an impact on the price of the underlying stock in the spot market.

How stock price manipulation works

Pump & dump: This classic modus operandi of stock price manipulators is usually done in connivance with the promoters. Here's how it works:

They spread positive, but false, news about the stock they have bought in large numbers.

The company may join in with positive announcements of large orders, new products, etc.

In some cases, it may even fudge its accounts to suggest a financial turnaround. Unwitting small investors are lured by the opportunity and start buying the stock.

This creates a high demand situation, thus 'pumping up' the price of the stock.

Once their target price is reached, the operators and promoters start 'dumping' the shares. The share price drifts down and eventually reaches its prepumping level.

Short & distort: This strategy is adopted by bear cartels and typically doesn't involve promoters. Though any stock can be short-sold, bear cartels target those that have been ramped up by operators for better results.

Instead of buying the stock and then artificially pumping up its price before selling, the operators shortsell the stock.

They then spread negative information regarding the stock and offer poor predictions and targets for the scrip.

Once the stock price falls below the target price, the operators buy back the shares and earn a handsome profit from the short-selling.

Not limited to mid-caps

However, the problem is not limited to midand small-cap stocks. Even large-cap stocks or blue chips can figure on the radar of operators. Take the sharp drop in the share price of NHPC. Its price was dragged down nearly 30% with heavy volumes.

NHPC is a PSU stock and there is no evident promoter interest in ramping up the stock price. This was more a case of 'collateral damage', where the operators may have tried to manipulate some other stocks while taking margins based on fundamentally strong stocks like NHPC.

When the effort to manipulate fails and the operator is not able to make the payment, the broker sells the stocks put up as margin (NHPC in this case), bringing down the stock price suddenly. Unnerved by the sudden fall, the institutions that hold these stocks may also dump them. Since stocks like NHPC are also traded in the futures & options (F&O) segment, traders tag along, resulting in a compounding of the problem. The NHPC crash is more worrisome because it is seen as a stable company with a proven track record. How can such a stable counter experience such a sharp slide without any justification? "It is not just the mid- and small-cap stocks that are vulnerable. Investors need to be watchful even while dealing with the more popular stocks," cautions Alok Churiwala, managing director, Churiwala Securities.

Buy penny stocks at your own risk

Want to invest in the IT sector? With Rs 9,000 you can buy three shares of Infosys Technologies—or 3,000 shares of Software Technology Group. The very thought that they can buy 1,000 times more shares makes many investors walk into the trap of penny stocks. These are so called because they are trading at very low prices, usually below Rs 10.

The price may be low, but the mistake of investing in a penny stock can be very costly. Infosys has risen in value and enriched investors with dividends and bonus issues. The last time that Software Technology Group was trading above Rs 10 was in September 2009. The company has been in losses for the past two years and has no reserves.

Now you know why one is trading at Rs 3,000 and the other at Rs 3. There is a greater chance of Infosys rising by Rs 500 than the Software Technology Group by 50 paise. Besides, the average daily traded volume of Infosys in the past 30 days is 11 lakh shares. Only 2,800 shares of Software Tech have been traded daily.

So you have a slim chance of getting out when you want to. Even so, penny stocks are traded with great expectations on the bourses. Given the low base, these stocks can potentially offer massive returns. However, the risk of losing capital is also higher. A recent study by the ET Intelligence Group shows that of the 494 penny stocks trading at the beginning of 2008, only 115 have risen in value. Even among the winners, only a handful became multi-baggers.

What makes penny stocks risky? Most are small, obscure firms about which information is not available. No analyst spends time researching these scrips. The market cap is also very low, making them easy targets of price manipulation. Unscrupulous promoters keep trying to pump up the price even as operators lure unsuspecting investors to these scrips. It's a treacherous territory with cautionary 'no entry' signs. Ignore them at your own peril.